Securities Lawyer 101 l Brenda Hamilton

Saturday, September 21, 2013

Depository Trust Company

Q. What is The Depository Trust Company (DTC)?

A. It is the only stock depository in the United States.

Q. How do public companies obtain DTC eligibility?

A. Issuers must satisfy specific criteria established by DTC to receive initial DTC eligibility after their going public transaction is complete, and to remain DTC eligible. Even after the securities become DTC eligible, DTC may limit or terminate its services.

Q. How does DTC limit its services?

A. DTC limits its service by placing a chill (“DTC Chill”) on a security and terminates its services by placing a lock (“Global Lock”) on the security. This often happens when there is a suspicion of fraud or unregistered securities issuances.

Q. Why is DTC so important to public companies and companies going public?

A. When DTC provides services as the depository for an issuer’s securities, its securities can trade electronically. Without DTC eligibility, it is almost impossible for an issuer to establish an active market in its stock. This is especially important for private companies going public who are seeking to raise capital.

Q. Is there a Conspiracy between the DTC and the SEC to eliminate or reduce the number of microcap companies by DTC placing global locks and chills on their securities?

A. When DTC eligibility is limited or terminated, issuers and their securities attorneys often scream foul play asserting various conspiracy theories, each more ludicrous than the last. We have all read about issuers who self-righteously proclaim that their loss of DTC was due to conniving short sellers, nefarious clearing firms and the purported “agenda” of the SEC to eliminate small broker dealers and microcap issuers.

When DTC eligibility is lost, issuers will often tell their stockholders, they have no idea what happened. Since only the company can direct its transfer agent to issue free trading shares, most often the issuer knows exactly why DTC limited or suspended its services.

Q. If I obtain a legal opinion from my securities lawyer will my company get DTC eligibility restored after a chill or global lock?

A. It typically takes more than a form legal opinion. Often times, tradability legal opinions rendered for microcap companies are legally baseless. This is proven by the number of securities attorney who are the subject of SEC enforcment actions. Many officers and directors of microcap companies are facing the harsh reality that reliance upon a legal opinion will not enable them to get a DTC Chill or Global lock removed. DTC reserves the right to refuse to rely upon the opinion of any issuer’s securities attorney. In the last few years, the SEC has brought multiple enforcement actions against attorneys in connection with tradability opinions rendered for microcap issuers. Often these actions are preceded by a loss of DTC eligibility.

Q. What Is DTCC’s Office of Corporate and Regulatory Compliance and what do they do?

A. DTCC’s Office of Corporate and Regulatory Compliance monitors unusually large deposits of microcap securities that are deposited into DTC when there is a suspicion or indication that the issuer or persons associated with the issuer have violated the securities laws.

With Microcap stocks, this behavior typically involves the deposit of large blocks of illegally unrestricted securities rendered in connection with convertible notes, reverse merger transactions or Rule 504 offerings.

Q. Does FINRA have anything to do with all the DTC Chills?

A. DTC review is also prompted when issuers provide notice to FINRA pursuant to Rule 6490, of certain corporate actions. While FINRA examines the corporate action prompting the notice under 6490, DTC reviews matters related to the issuer’s shares including the tradability of the securities it holds on deposit in the name of CEDE & Co.

DTC staff may discover (previously undetected) illegal free trading share issuances or other fraudulent activity that will persuade them to limit or suspend its services. In these instances, DTC may make referrals to appropriate regulators including the SEC’s Division of Enforcement.

Q. How will a DTC Chill or Global Lock impact trading of my company’s stock?

A. DTC Chill restricts DTC’s services, including limiting a DTC participant’s ability to deposit or withdraw chilled securities. A DTC Chill may last a few days or for an extended period of time depending upon the problems that caused the chill and the issuer’s willingness to address them. A “Global Lock” is a termination of all of DTC’s services to an issuer. Like a DTC Chill, a Global Lock may last a few days or for an extended period of time, depending on the reason for the action. If the fundamental issue cannot be corrected, then the security will be removed from DTC’s depository, and transactions in the security subject to the Global Lock will no longer be eligible for clearing at any registered clearing agency. When this happens, clearance and settlement of open market trades is significantly delayed because trades can only occur upon physical delivery of stock certificates between the buyer and seller’s brokerage firms. In such circumstances it could take weeks for trades to clear and settle.

Q. Will DTC tell me why my stock is chilled?

A. DTC does not always disclose the reason for a chill or Global Lock, nor does it suggest how long it will be in effect.

A. Generally, two people are needed to help an issuer remove a chill. These are a securities attorney acceptable to DTC who can conduct an analysis of the shares held in the name of CEDE and Co and a DTC Market participant, who can ask that DTC provide its services with respect to a security. Anyone else claiming he can secure DTC eligibility or remove a DTC Chill is not qualified or able to do so.

Q. Will filing a registration statement with the SEC as part of a going public transaction make it easier for an issuer to obtain DTC eligibility?

A. Generally, yes because the issuer’s securities are subject to a registration statement filed with the SEC it is less likely that unregistered securities have been improperly issued. Some DTC Market participants are broker-dealers and some transfer agents.

Q. Who are DTC market participants?

A. Some DTC Market participants are broker-dealers and some transfer agents.

Q. Will DTC Ever Remove a Chill or Global Lock?

A. Yes, the DTC has removed chills that it placed on the securities of multiple public companies. In some circumstances, DTC obtains additional information from the issuer and an opinion from its securities attorney regarding the activity in question,

Q. What are the fairness procedures that apply to DTC?

A. On September 24, 2009, the SEC determined that DTC must provide issuers with fairness procedures, adding further that DTC’s suspension of its services to an issuer is subject to SEC review upon request. Unfortunately, the SEC has not defined adequate fairness procedures precisely. Even with a fairness hearing there can be no assurance that DTC will resume its services for an issuer’s securities; DTC continues to have a broad discretion with respect to its services.

Q. What should I do if I want to get DTC eligibility after my going public transaction or have DTC’s services restored after a Chill or Global Lock?

A. Because DTC may choose to refer securities violations it discovers to the SEC’s Division of Enforcement, issuers should with a securities attorney at all stages of the DTC process, particularly when information must be provided by the issuer. The selection of a securities attorney to address DTC problems, and potential problems, should not be considered a routine legal matter.